Fair warning. Contract terminations often come loaded with expected and unexpected requirements. Knowing what to do and when to do it can make all the difference. Almost every Federal contract or solicitation contains provisions that allow the Government to terminate the contract, either for convenience or for default, as explained below:
- Termination for Convenience (T for C): The Government may terminate performance of work under a contract in whole or in part if the Government Contracting Officer (CO) determines that a termination is in the Government’s interest.
- Termination for Default (T for D): The Government may completely or partially terminate a contract because of a contractor’s actual or anticipated failure to perform its contractual obligations.
The contractor’s goal under any Government contract is to provide adequate performance that addresses the contract requirements. Although contractors do not enter into contracts expecting them to be terminated, they need to understand the termination process in order to respond appropriately to unanticipated documentation, reporting, and accounting requirements. With regard to termination for convenience, these requirements often impact the settlement and disposition of inventories and equipment activities.
The Contract Termination Process
Contract termination is rarely a surprise event. Prior to a termination, many events such as change orders and stop work notifications may warn a contractor of an impending termination. When no other options appear to exist, the CO will discuss the issues and performance concerns with the contractor, providing written notifications and direction in accordance with FAR termination requirements. This information may come in the form of a corrective action plan request, notice of termination for convenience, or similar documentation.
A written notice of termination specifies the extent of the termination and the effective date. These notices often contain both information based on the contractor’s circumstances and the nature of the contractor’s products or services that are being terminated. Also, under a termination of convenience, contractors may find that only portions of the contract have been terminated. Nonetheless, the contractor must comply with the notice and the requirements of the applicable Federal Acquisition Regulation (FAR) termination clause, except as otherwise directed by the Termination Contracting Officer (TCO). Regardless of any delay in determining or adjusting any amounts due to the contractor for work performed, and for any costs incurred prior to issuance of the termination notice, the contractor has a general obligation to:
- Stop work immediately. The contractor must notify its project team, including suppliers and subcontractors, to stop work immediately on the terminated portion of the contract and stop placing subcontracts thereunder.
- Terminate subcontracts, purchase orders, and other agreements. The contractor must terminate all agreements related to the terminated portion of the contract, preferably through a written notice referencing the flow down clauses and circumstances.
- Advise the TCO of any special circumstances. The contractor must quickly advise the TCO of any special circumstances that would preclude the immediate stoppage of work.
- Submit equitable adjustment. Under the termination clause, after partial termination a contractor may request an equitable adjustment of the price or prices of the continued portion of a fixed-price contract.
- Protect and preserve property. The contactor must take necessary or directed action to protect and preserve property in the contractor’s possession in which the Government has or may acquire an interest. If directed by the TCO, it must deliver the property to the Government.
- Notify the TCO of any legal proceedings. The contractor must promptly notify the TCO in writing of any legal proceedings stemming from any subcontract or other commitment related to the terminated portion of the contract.
- Settle outstanding liabilities and proposals arising out of termination of subcontracts. The contractor must settle outstanding liabilities arising out of termination of subcontracts, obtaining any approvals or ratifications required by the TCO.
- Submit a settlement proposal. The contractor must promptly submit its own settlement proposal, supported by accounting data and appropriate schedules sufficient for adequate review within 365 days of receipt of the termination notice. There are three major Government settlement proposal forms, differing based on the type of terminated contract:
- Standard Form (SF) 1435: Settlement Proposal (Inventory Basis) (see FAR 53.249(a)(2))
- SF 1436: Settlement Proposal (Total Cost Basis) (see FAR 53.249(a)(3))
- SF 1438: Settlement Proposal (Short Form) (used when the total charges being proposed are less than $10,000) (see FAR 53.249(a)(5))
- Dispose of termination inventory. The contractor must dispose of termination inventory within 120 days, unless otherwise negotiated with the TCO. The contractor must also properly report and coordinate with the Government plant clearance officer (PLCO) in reporting and coding inventory.
What Happens Next?
After the settlement proposal is submitted, the TCO will examine each associated subcontract settlement to determine if subcontract terminations were necessary because of the termination of the prime contract. The TCO will also determine if the contractor’s settlement proposal was developed objectively and reasonably, the associated proposed prices are fair and reasonable, and the proposed prices are allocable to the terminated portion of the contract.
In considering the reasonableness of any associated subcontract settlement, the TCO will generally be guided by the provisions relating to the settlement of prime contracts and will comply with any applicable requirements of FAR 49.107, Audit of Prime Contract Settlement Proposals and Subcontract Settlements, and FAR 49.111, Review of Proposed Settlement, relating to accounting and other reviews. After the examination, the TCO will notify the contractor in writing of approval, ratification, or the reasons for disapproval of the contemplated settlement proposal.
As shown in the table below, the FAR contains numerous termination clauses that apply to specific contract types:
What Does CohnReznick Think?
CohnReznick appreciates the opportunity to help Government contractors identify potential ramifications that may occur during the contract termination process. Toward that end, we have several resources you should look into:
- CohnReznick Insights (www.cohnreznick.com/insights): Provides CohnReznick’s latest insights on business trends, regulatory developments, and economic issues. You can subscribe to receive Insights e-newsletters by email.
- CohnReznick Website (www.cohnreznick.com): In addition to Insights, our website provides extensive information about all aspects of Accounting and Assurance, Tax, and Advisory services.
- CohnReznick GovCon360 (www.govcon360.com): Keeps you up-to-date on the ever-changing regulatory environment that is government contracting. From reference materials to educational presentations and thought leadership pieces on industry matters, GovCon360 is a valuable resource for the Government contracting professional.
- FAR Part 49, Termination of Contracts: http://farsite.hill.af.mil/reghtml/regs/far2afmcfars/fardfars/far/49.htm
- FAR Clauses 52.249-1 through 52.249-12: http://farsite.hill.af.mil/reghtml/regs/far2afmcfars/fardfars/far/52_246.htm